World economy is relying on Europe and Asia

Going into next year, the pace of expansion is slowing due to dampeners on consumption, but a global slump is probably not on the cards thanks to Germany and Japan

By Ashley Seager / THE GUARDIAN , LONDON

The recent flow of news from around the world suggests that the balance of world economic power may finally be swinging away from the US -- the powerhouse of the past decade or more -- towards Japan and Europe, which have lagged behind for many years.

The world economy has put in its fastest growth spurt for decades over the past three years, and is still bowling along at a healthy clip this year, despite a tripling of oil prices since early 2004.

China and India continue to grow at breakneck speed but many economists are fearful that the interest rate rises by the world's central banks this year, led by the US Federal Reserve, could put a swift brake on the world economy next year.

Indeed, the US economy has already slowed, expanding at an annual pace of only 2.5 percent in the second quarter. With news this week that the 12-member eurozone expanded at an annualized rate of 3.6 percent in the April to June period, Europe is suddenly growing faster than the US.

Britain, too, has recovered from last year's slowdown and expanded at an annualized 3.2 percent in the second quarter.

The key to how modern economies work often lies in consumer spending since this now accounts for two thirds of a developed economy. In the US, the successive rate rises from the Federal Reserve have dampened the housing market, something that is expected to slow consumer spending as US citizens will no longer be able to use their houses as ATM machines to fund spending.

The big question for the eurozone is whether the economic recovery, which has been led by German exports to the US and Asia, can encourage consumer spending sufficiently to ensure Europe remains on the recovery path and helps boost the world economy rather than just being dependent on it.

"While eurozone consumer spending has picked up overall this year compared with 2005, consumers are still relatively cautious," said Howard Archer, an analyst at Global Insight.

High unemployment across the bloc has kept consumer spending subdued, particularly in Germany. There are, however, signs that this might be changing. Figures out this week showed employment growth has picked up and is now outpacing that of the US, which has slowed down.

About 200,000 jobs a month are being created, about four times the amount through most of last year. French job growth is running at its fastest pace for five years.

Holger Schmieding, an economist at the Bank of America in London, thinks the eurozone recovery has sufficient momentum to continue next year even if the world economy slows down and the European Central Bank continues to raise interest rates to dampen inflation.

"Stronger employment growth and a modest pick-up in wage inflation are the major reasons why we do not expect the modest fiscal tightening in the eurozone scheduled for next year to derail the eurozone recovery in 2007," he said, referring to a tax rise in Germany scheduled for the beginning of next year, which some analysts fear could clobber consumer spending in Germany, Europe's largest economy.

Schmieding, though, thinks spending patterns will be disrupted rather than reduced as Germans bring forward spending to late this year to beat the tax increase.

In Britain, Europe's second largest economy, retail sales were bowling along healthily until July when they slumped after the World Cup. Consumer spending has been strong in Britain for several years and has helped the economy to easily outpace that of the eurozone.